Draft Capital Requirements (Amendment) (EU Exit) Regulations 2018 Draft Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018

Jonathan Reynolds Excerpts

Wednesday 12th December 2018 General Committees

[Jonathan Reynolds (Stalybridge and Hyde) (Lab/Co-op)]

It really is a pleasure, Ms Buck, to serve under your chairmanship. Once again, the Minister and I find ourselves in this room, as we work through the list of dozens of Treasury statutory instruments that are needed as we prepare for EU withdrawal. It is nice to see that there is a crowd this morning—there must be something else going on today, perhaps later on.

On each of these occasions, I and my Front-Bench colleagues have spelled out our objections to secondary legislation being used in this manner, as well as the challenges of ensuring that there is proper scrutiny, given the sheer volume of legislation passing through these Committees. All of this legislation is speculative, as it prepares us for a UK no-deal exit. It feels surreal to stand here discussing the finer points of financial regulation when the overall process is in total chaos.

It is near inconceivable that we are now so close to exit with no agreement in place and no vote scheduled on any such agreement. That places even greater importance on the work we are doing here, as with every passing day that this chaotic situation is not resolved, we inch closer to crashing out of the EU without a deal. That is a frightening prospect, particularly for financial services and especially for those parts of financial services that cannot operate within an equivalence framework.

Therefore, it is of the utmost importance that the statutory instruments are rigorous in their approach to ensuring the EU financial regulatory framework. The two instruments up for discussion today are of central importance to the stability of our financial system. Both the capital requirements and the recovery and resolution regime were designed to prevent the events of 2008 ever being repeated, given the catastrophic economic consequences. They required considerable co-operation across Europe, supported by wider efforts to comply with new rigorous international standards. Dismantling any element of that regime would be very ill advised, and we do not want to find ourselves in a position where Governments ever have to bail out the banks again.

With that in mind, I will begin by addressing the draft capital requirements instrument. I want to flag a major concern at how this provision is being transposed into UK law, and the potential disadvantage for UK banks. Colleagues will know that the EU capital requirements regulation mandates banks and financial institutions to maintain levels of sufficient quality capital, so that they are more resilient in market downturns or distress and, therefore, less likely to collapse. Different metrics are used to assess the quality of capital, and institutions are required to hold assets in certain ratios to comply with the regulation. It appears that this statutory instrument will remove preferential treatment for EU government debt for UK banks and, therefore, put UK banks holding EU government debt as a capital buffer at a disadvantage, as the Minister confirmed in his opening remarks.

EU member states’ government debt is considered very safe by the EU and banks do not need to hold much to meet regulatory requirements. If there is no agreement on equivalence for financial assets, the capital requirements statutory instrument says that UK government debt will no longer be considered so safe by the EU itself and, therefore, the UK Government will respond by removing preferential treatment for EU debt.

The guidance states:

“Once the UK has left the EU, in the absence of an agreement and where no equivalence determination has been made, the EU27 would automatically fall into the category of a third country where EU27 exposures would no longer receive preferential capital treatment. Therefore, this SI will remove preferential treatment for EU27 exposures.”

On the face of it, that will leave UK banks that hold EU government debt suddenly at a higher risk from a pricing perspective. It will become more expensive for them to hedge their risks in a no-deal environment, where markets are likely to be extremely volatile anyway. Trade publication GlobalCapital expresses that simply as a

“hit to UK bank capital ratios at the worst time imaginable”.

Where does that leave UK banks with significant EU operations, which are likely to hold this type of debt in large quantities? The Minister has repeatedly assured us that no substantive changes are being made from a policy perspective in the transposition of the rules through statutory instruments, but it seems this risks having a real and negative impact through a decision to change the treatment of EU government debt. Will the Minister please explain how the decision was reached and how it could be remedied to prevent increasing costs for UK banks and the requirement to re-hedge their positions?

The second instrument relates to a framework closely associated with the capital requirements: the recovery and resolution regime. That relates to so-called living wills for financial institutions if they fall into credit-related difficulties. That is another mission-critical strand of post-crisis regulation that continues to evolve.

The Bank of England has announced its plan to bring in a self-assessment regime for UK banks from 2020, which will require them to demonstrate their own winding down and restructuring plans for times of distress, without causing market contagion or requiring a taxpayer bail-out.

The guidance to the bank recovery and resolution statutory instrument states that:

“HM Treasury’s approach to onshoring the Bank Recovery and Resolution Directive is to ensure that the UK’s Special Resolution Regime is legally and practically workable on a standalone basis once the UK has left the EU.”

The challenge is how we can ensure that the recovery and resolution regime continues to be effective while potentially operating in isolation. Realistically, most of the biggest firms in this country are cross-border, so close co-operation will be needed with our EU counterparts to ensure that the risk of contagion is minimised and our approach is consistent. The statutory instrument is very light on detail in that regard. Will the Minister elaborate on the Treasury’s role in ensuring that this approach is followed? Is there an existing interaction with a third country or with third-country firms that the Treasury is using as a guide?

The banking framework in the UK has evolved significantly since 2007 to the benefit of both the taxpayer and market stability. Much of that has been achieved through close international co-operation with the EU and G20. We need to make sure that any future framework enshrines that hard work, especially as banks and financial institutions are likely to be highly stressed by market conditions if we crash out without a deal. Sadly, given the chaotic back and forth of the Government this week, the reality is that the prospect of no deal is becoming likelier by the day.

--- Later in debate ---

[John Glen]

I thank the hon. Members for Stalybridge and Hyde and for Glasgow Central for their questions, and acknowledge concerns about the rigour of the process. All I can say to the Committee is that I am doing everything I can to ensure that it is as rigorous as possible.

For both statutory instruments, there was significant engagement with industry and the regulators. The draft Capital Requirements (Amendment) (EU Exit) Regulations 2018 were laid on 21 August, with an explanatory note seeking to draw out concerns. The draft Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018 were laid on 8 October for consideration.

The hon. Member for Stalybridge and Hyde accurately characterised the global drivers of the regulations. I want to address the specific concern he raised about the directive on the change in capital requirements consequent on our leaving in a no-deal scenario. He is right to say that the capital requirements regulation specifies how much capital and liquidity firms must hold against different types of exposures. He is right that certain EU assets are subject to a 0% risk weight, meaning that no capital needs to be held against those exposures. However, in a no-deal scenario, the UK will treat the EU as a third country and vice versa.

Without an assessment of equivalence between the EU countries and the UK, the EU would end preferential capital treatment for UK exposures, so it has been Government policy not to grant the EU unilateral preferential treatment in the absence of equivalence, and the SI makes the appropriate amendments to ensure that EU sovereign debt is no longer treated more favourably than other assets of a similar nature.

[Jonathan Reynolds]

Will the Minister give way?

[John Glen]

Perhaps I may just make the next point, and see whether it addresses the hon. Gentleman’s concern.

EU sovereign debt will none the less retain the low risk ratings that sovereign debt typically attracts. In addition, we are introducing transitional powers for the regulators to phase in the new requirements. That is up to two years, mitigating much of the impact.

[Jonathan Reynolds]

I am grateful for that clarification, and for the second point in particular. I understand the political case for not having a unilateral preferential regime that is not reciprocated by the EU. However, when we think about all the market volatility and stress that no deal gives us, to reclassify the capital adequacy of UK resident banks feels quite difficult, even if it is phased in over a period of two years, which is not that significant to be honest.

[John Glen]

I acknowledge how it sounds, but this is a regulatory change to enable the discretionary power. The Government’s intent is to make prudential assessments in a non-politicised way.

[Mr Richard Bacon (South Norfolk) (Con)]

May I say how delighted I am that the Government are taking an approach that allows discretion? That was one enormous problem at the time of the financial crash, which was also a sovereign debt crisis. The hon. Member for Stalybridge and Hyde forgot to mention who was in charge at the time. That crisis was exemplified perhaps most clearly by Gordon Brown standing outside the shiny new Lehman Brothers office when it opened, shortly before the crash. The capital regime was so inadequate at the time under that regime—

[Jonathan Reynolds]

In America?

[Mr Bacon]

In London. The point I was going to make, and why I am so glad that the Minister is introducing provisions for discretion, is that part of the problem of the sovereign debt crisis was that—